Friday, April 27, 2018

FBAR violation can be shown by preponderance of the evidence and willfulness by reckless conduct

Under the Bank Secrecy Act, U.S. citizens must file an FBAR with the U.S. Treasury disclosing any financial account in a foreign country with assets in excess of $10,000 in which they have a financial interest, or over which they have signatory or other authority.

Those who willfully fail to file their FBARs on a timely basis can be assessed a penalty of up to the greater of $100,000 or 50% of the balance in the unreported bank account for each year they fail to file a required FBAR. IRS has discretion as to the amount of the penalty, subject to these limits

A "reasonable cause" exception exists for non-willful violations, but not for willful ones.

Courts have previously considered the level of the burden of proof needed sustain civil penalties for a willful failure to file the FBAR disclosure by holding that the preponderance of the evidence standard governs suits by IRS to recover civil FBAR penalties[1].

A number of courts have found that willfulness in the civil FBAR context includes reckless conduct[2].

In a case dealing with a fraudulent misrepresentation claim, the Supreme Court held that a heightened clear and convincing burden of proof applies in civil matters "where particularly important individual interests or rights are at stake." (Herman & MacLean v. Huddleston, 459 U.S. 375 (S Ct 1983)) Such interests include parental rights, involuntary commitment, and deportation. The lower, more generally applicable preponderance of the evidence standard applies, however, where "even severe civil sanctions that do not implicate such interests" are contemplated.

In U.S. v. Garrity, 121 AFTR 2d ¶2018-629, (DC CT, 4/3/2018) the IRS filed suit to reduce to judgment a civil penalty that it assessed against Paul G. Garrity, Sr. for his alleged willful failure to report his interest in a foreign account that he held in 2005.

In anticipation of trial, the parties submitted briefs addressing the legal question of what standard of proof governs; preponderance of the evidence or clear and convincing evidence. IRS argued that the standard of proof was preponderance of the evidence. The taxpayer argued that the standard of proof was clear and convincing evidence.

The parties also briefed the separate question of whether IRS must show that Mr. Garrity, Sr. intentionally violated a known legal duty to establish a "willful" FBAR violation (as the taxpayer's representatives contended) or whether IRS may satisfy its burden of proof by showing that Mr. Garrity, Sr. acted recklessly (as IRS contended).

The district court determined that IRS must prove the elements of its claim for a judgment by a preponderance of the evidence and that proof of reckless conduct would satisfy IRS's burden on the element of willfulness.

The district court found that the civil FBAR penalty did not implicate important individual interests or rights. The court reasoned that the fact that the taxpayers might be liable for a substantially larger sum of money for a willful FBAR violation than if IRS had pursued a civil tax fraud action did not warrant a higher standard of proof. As Huddleston indicated, it was the type of interest or right involved that triggered a higher standard of proof, not the amount in controversy. 

The district court reasoned that the sanction that the taxpayer might be exposed to, regardless of how "draconian" it might be, was monetary only. Despite characterizing the taxpayer's exposure to a monetary sanction as implicating a "property interest that require[s] protection" the taxpayer's representatives had not demonstrated how the penalty IRS sought would affect important individual interests or rights to warrant a higher standard of proof.

The taxpayer's representatives also argued that IRS's proof of willfulness likely would involve allegations of fraud, which could tarnish Mr. Garrity, Sr.'s reputation, implicating a more important interest than those involved in typical civil cases. But the court, looking to Huddleston and noted that even allegations of fraud did not necessitate a higher standard of proof. Unlike a large number, and perhaps the majority, of the States, Congress had chosen the preponderance standard when it has created substantive causes of action for fraud.

While the taxpayer's representatives conceded that numerous courts had found that willfulness in the civil FBAR context included reckless conduct, relying principally on criminal cases, they maintained that IRS must prove that Mr. Garrity, Sr. intentionally violated a known legal duty in order to satisfy the element of willfulness, and that proof of reckless conduct was insufficient. The district found that the taxpayer's representatives ignored the clear distinction that the Supreme Court had drawn between willfulness in the civil and criminal contexts[3]. The taxpayer's representatives pointed to no other authority that would warrant deviating from the Supreme Court's holdings that statutory willfulness in the civil context covered reckless conduct.

The District Court held that IRS may prove that a taxpayer failed to timely file a Foreign Bank and Financial Accounts Report (FBAR) by a preponderance of the evidence rather than by a higher, clear and convincing evidence standard. The court also determined that IRS could show willfulness on the taxpayer's part by proof of his reckless conduct and did not need to show that he intentionally violated a known legal duty.


[1] (Bedrosian v. U.S., (DC PA 9/20/2017) 120 AFTR 2d 2017-5832 ; U.S. v. Bohanec, (DC CA 2016) 118 AFTR 2d 2016-6757 ; U.S. v. McBride, (DC UT 2012) 110 AFTR 2d 2012-6600 ; U.S. v. Williams, (2010, DC VA) 106 AFTR 2d 2010-6150 , rev'd on other grounds, U.S. v. Williams, (CA 4 2012) 110 AFTR 2d 2012-5298
[3] See Ratzlaf v. U.S.,(S Ct 1994) 510 U.S. 135.

Monday, April 16, 2018

Distributions from account that had ceased to be an IRA were not taxable

Stacey Marks owned a retirement account, the custodian of which was the Argent Trust Co. (the Argent account). Before 2005, the Argent account qualified as an IRA.

In 2005, the Argent account made a $40,000 loan to Marks' father. It received a promissory note in exchange. In 2012, the Argent account made another loan, of $60,000, to one of Marks' friends, again receiving a promissory note in exchange.

As of December 2013, the Argent account had the following assets: (1) the two notes (with a combined face value of $100,000) and (2) $96,508 in cash. In December 2013, Marks opened a new retirement account, the custodian of which was the Equity Trust Co. (the Equity account). In December 2013, Marks attempted to roll over the assets of the Argent account to the Equity account.

On her 2013 tax return, Marks did not report that she had received a taxable distribution from the Argent account.

IRS initially determined that Marks successfully rolled over the $96,508 into the Equity account, but that the two notes were not successfully rolled over and thus had to be included in income in 2013. In its deficiency notice, IRS found that she had received a $98,000 taxable distribution from the Argent account (representing the two notes; it's unclear why they weren't valued at their full $100,000 face value), and that this amount was subject to the 10% additional penalty on early distributions under Code Sec. 72(t), and that Marks had a substantial underpayment of tax and was thus subject to a $7,071 accuracy-related penalty.

Marks challenged the determination, asserting that the two notes were distributed to her then rolled over into the Equity account.

The Tax Court, after reviewing the parties' positions, ordered them to file additional memoranda addressing the effect of the prohibited transaction rule under Code Sec. 408(e)(2)(A).

Both sides agreed that, by making the loan to Marks' father in 2005, the Argent account had engaged in a prohibited transaction and ceased to be an IRA.

Accordingly, as agreed by the parties, the Tax Court held that Marks was not required to include the $98,000 in income for 2013 because the distribution was not from an IRA. As a result, the early distribution penalty didn't apply, and there was no substantial understatement of tax giving rise to a penalty under Code Sec. 6662.
What the court did not address was whether a tax can be levied against the taxpayer for the prohibited transaction in 2005. As the audit year was 2013 it is likely that the 3 year and 6 year statute of limitations has expired and barring fraud there would be no way for the IRS to make an assessment.

Tuesday, March 27, 2018

Pass-Through Guidance Out By Summer At Earliest, IRS Says

The Internal Revenue Service will likely issue further guidance on the rule that affects how pass-through entities are taxed under the new federal tax law by late summer or early fall, the agency’s top official said Monday.

David Kautter, the acting IRS commissioner and Treasury assistant secretary for tax policy, said the IRS was working to provide answers surrounding this provision of the rule, Internal Revenue Code § 199A, in the wake of the federal tax overhaul. The guidance is essentially being built from the ground up.

Until then advice to client should be limited.  If late summer means early fall...will there be any time to plan?

Monday, March 19, 2018

Will the IRS Increase Criminal Prosecutions Now That the OVDP Program is Ending?

 As previously reported the IRS has announced that the offshore voluntary disclosure program (OVDP) will be closing on September 28, 2018. It appears that the program which began in 2009 only had 56,000 taxpayers who used one of the programs to comply voluntarily. This is an underwhelming number of taxpayers. Indeed they were only 600 disclosures in 2017. What does that mean?

 Since 2009, the IRS criminal investigation unit has investigated 1545 taxpayers on criminal violations related to international activities, of which 671 were indicted on international criminal tax violations.

 The IRS is now sending a clear signal that rather than relying on the voluntary disclosure program it will increase criminal prosecutions to effect compliance. Those who have not complied should heed this warning and file a disclosure before the deadline or otherwise face criminal prosecution!


Thursday, March 15, 2018

IRS to end offshore voluntary disclosure program; Taxpayers with undisclosed foreign assets urged to come forward now

The Internal Revenue Service today announced it will begin to ramp down the 2014 Offshore Voluntary Disclosure Program (OVDP) and close the program on Sept. 28, 2018. By alerting taxpayers now, the IRS intends that any U.S. taxpayers with undisclosed foreign financial assets have time to use the OVDP before the program closes. “Taxpayers have had several years to come into compliance with U.S. tax laws under this program,” said Acting IRS Commissioner David Kautter. “All along, we have been clear that we would close the program at the appropriate time, and we have reached that point. Those who still wish to come forward have time to do so.”

Since the OVDP's initial launch in 2009, more than 56,000 taxpayers have used one of the programs to comply voluntarily. All told, those taxpayers paid a total of $11.1 billion in back taxes, interest and penalties. The planned end of the current OVDP also reflects advances in third-party reporting and increased awareness of U.S. taxpayers of their offshore tax and reporting obligations.

The number of taxpayer disclosures under the OVDP peaked in 2011, when about 18,000 people came forward. The number steadily declined through the years, falling to only 600 disclosures in 2017.

The current OVDP began in 2014 and is a modified version of the OVDP launched in 2012, which followed voluntary programs offered in 2011 and 2009. The programs have enabled U.S. taxpayers to voluntarily resolve past non-compliance related to unreported foreign financial assets and failure to file foreign information returns.

Tax Enforcement

The IRS notes that it will continue to use tools besides voluntary disclosure to combat offshore tax avoidance, including taxpayer education, Whistleblower leads, civil examination and criminal prosecution. Since 2009, IRS Criminal Investigation has indicted 1,545 taxpayers on criminal violations related to international activities, of which 671 taxpayers were indicted on international criminal tax violations. “The IRS remains actively engaged in ferreting out the identities of those with undisclosed foreign accounts with the use of information resources and increased data analytics,” said Don Fort, Chief, IRS Criminal Investigation. “Stopping offshore tax noncompliance remains a top priority of the IRS.”

Streamlined Procedures and Other Options

A separate program, the Streamlined Filing Compliance Procedures, for taxpayers who might not have been aware of their filing obligations, has helped about 65,000 additional taxpayers come into compliance. The Streamlined Filing Compliance Procedures will remain in place and available to eligible taxpayers. As with OVDP, the IRS has said it may end the Streamlined Filing Compliance Procedures at some point.

Because the circumstances of taxpayers with foreign financial assets vary widely, the IRS will continue offering the following options for addressing previous failures to comply with U.S. tax and information return obligations with respect to those assets:

  • IRS-Criminal Investigation Voluntary Disclosure Program;
  • Streamlined Filing Compliance Procedures;
  • Delinquent FBAR submission procedures; and
  • Delinquent international information return submission procedures.

Tuesday, February 27, 2018

Tuesday, July 25, 2017

Ultrasound Service Company was a PSC

In Reza Zia-Ahmadi, et ux., et al. v. Commissioner, TC Summary Opinion 2017-39 the taxpayers was the principal of Sound Diagnostic (a C corporation) which provided ultrasound services to medical offices and clinics throughout southern Colorado. Sound Diagnostic entered into professional service agreements with three medical clinics (professional service agreements) in 2009 and 2010. Under the professional service agreements, Sound Diagnostic contracted to provide ultrasound machines and “licensed medical professionals” qualified to perform echocardiography, cardiovascular, and vascular ultrasound services in the medical field of cardiology.

Generally, C corporations are taxed at graduated income tax rates. If, however, a C corporation is a qualified personal service corporation under IRC §448(d)(2), it will be taxed at a flat 35% income tax rate. IRC §11(b)(2).
A C corporation will be treated as a qualified personal service corporation if two tests are satisfied: (1) a function test and (2) an ownership test. IRC §448(d)(2)(A) and (B).
The court found that as the 100% principals of the company and the company employees the taxpayers met the ownership test.
The main issue was the Function Test. The requirements of the function test are met if substantially all of the corporation's activities involved the performance of services in one of the following qualifying fields: health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.
Section 1.4487-1T(e)(4)(ii) defines the provision of activities in the field of health as follows:
[T]he performance of services in the field of health means the provision of medical services by physicians, nurses, dentists, and other similar health-care professionals. The performance of services in the field of health does not include the provision of services not directly related to a medical field, even though the services may purportedly relate to the health of the service recipient. For example, the performance of services in the field of health does not include the operation of health clubs or health spas that provide physical exercise or conditioning to their customers.
Sound Diagnostic asserts that its employees do not perform services in the field of health because employees who operate the ultrasound equipment (sonographers) are not required to be licensed in Colorado, do not provide direct treatment services to patients, and do not make healthcare decisions.
The Court has held that the scope of the qualifying fields under IRC §448(d)(2) does not turn on State licensing laws citing Kraatz & Craig Surveying, Inc. v. Comm’r, 134 T.C. 167, 181 (2010). Rather, whether a service is performed in one of the qualifying fields “is to be decided by all relevant indicia, including the text of the statute, its legislative history and regulations, application of the normal meaning of the term `health'***and examination of services historically regarded as within the qualifying field.”
Sound Diagnostic proposes a narrow interpretation of the term “health”. The Tax Court previously rejected taxpayers' overly restrictive arguments in defining the various services listed in the IRC §448 temporary income tax regulations. Rainbow Tax Serv., Inc. v. Commissioner, 128 T.C. 42 (2007) (holding that the taxpayer's definition of accounting services was overly restrictive).
The court noted that the temporary income tax regulations do not so narrowly construe the requirements of the function test under IRC §448(d)(2). Rather, the phrase “field of health” includes services provided by healthcare professionals that are directly related to a medical field. See IRC §1.448-1T(e)(4)(ii).
The court cited the two year training which the taxpayer had to undergo to administer an ultrasound.
The court ruled that sonographers are more similar to physicians and nurses than to health club or health spa employees. Therefore, the taxpayer, in performing the ultrasound activities as a sonographer, was a healthcare professional.
Under IRC §448 a C corporation which is a personal service corporation can use the cash method even if their gross receipts exceed $5,000,000. That's the good news. The bad news is the result reached here; as a C corporation it earnings are taxed at the highest corporate rate.